Developments in UK insolvency by Michelle Butler

Some inflammatory remarks made as the BIS Committee interrogates the Insolvency Service

On 23 October 2012, the BIS Committee put questions to Dr Richard Judge, the Inspector General and Chief Executive of the Insolvency Service, and Graham Horne, the Deputy Inspector General and Deputy Chief Executive. The recording of the session can be found in the archive section of www.parliamentlive.tv.

Here I have set out the main points I drew from it and I have used quotes to avoid putting my own spin on the proceedings (although I could not refrain completely from adding some of my own observations). It is a long entry, I’m afraid, but here are the topics that I have covered:

Allegation of “age-old problem” of asset sales at an undervalue by IPs

What is being done about forcing suppliers to continue to supply?

Apparent disjoint between number of D1 reports and number of disqualifications being pursued

Proposals to affect pre-packs and what is to be done about continuously “disappointing” levels of SIP16 compliance?

Is the lower level of complaints as a whole a reflection of the current low-value cases or an indication of increased confidence in IPs?

The evolving plans to change complaints processes

Prospects for a single regulator

Progress in enhancing creditors’ powers to challenge excessive fees

Ideas arising from the Red Tape Challenge

“Perceived cosy relationship between IPs and asset-based lenders”

The session also covered questions on the Insolvency Service’s current and prospective resources, their projections of insolvency case numbers, the drop in their customer satisfaction rates, and more, but I realised that I had to stop somewhere!

Asset sales at an undervalue (timed at 9.47am in the recording)

Brian Binley (Conservative MP) started the discussion: “I’m particularly concerned about many small businesses who should be in receipt of some return for a sizeable build-up of debt and that build-up occurs because they daren’t be too heavy because the business has been fragile for 5 years or so and yet insolvency agents sell off at 10% irrespective and they feel very badly let down”.

I thought that Graham Horne did a reasonable job of explaining the considerable write-down of asset value on facing a fire-sale for a company in an insolvency process, but Mr Binley had not finished: “I do know how angry it makes people and particularly people running small businesses when they know the value is sizeably higher but where there is a culture of, because of the firewall (sic.) that you talk about, oh get rid of it, 10% will do… Can I ask you seriously to look into this matter and can I ask you to come back to me because I’m not satisfied with your answers and I think they have been sizeably complacent and I think that a consideration of SME is where hopefully the growth is going to come from and it needs to be higher up your list of priorities than it appears to be.”

It seems to me that there is still much work to do, primarily by R3 I would suggest, in progressing education of the public and politicians about the realities of insolvency. I would add that I think this is largely outside of insolvency regulation, is it not? An IP instructs a professional agent to do a professional job; I cannot see that they can be criticised for using accredited agents (say, by RICS and/or NAVA; I’m not sure of any other such bodies) to do their job, can they?

Continuation of supplies (10.00am)

Graham Horne stated that, in relation to the “regulated industries… we should do something about it and are doing something about it, so it’s no right that regulated industries should seek to profit because a company is going insolvent, whereas with a contracting party, it’s trickier. We’re aware of the issues; we are discussing them with IPs and others. It will require legislation. It’s really those unforeseen consequences – if you put a lever over here, you’re not totally sure what the consequences are over there at the moment – but certainly I think there’s a fair amount of forbearance around at the moment.”

The Insolvency Service’s record on director disqualifications (10.10am)

Mike Crockart (Lib Dem MP) observed that last year 5,401 D-reports were submitted, but only 1,151 resulted in disqualifications and he suggested that the perception is that directors who have been alleged as guilty of misconduct are not being tackled. Dr Judge responded by explaining the Insolvency Service’s strategy in prioritising high risk cases. He also explained that some cases are not taken forward because, inter alia, the evidence may not be there and he accepted that the Service has not been particularly good at explaining to IPs why cases have not been taken forward.

Mike Crockart responded: “You seem to be handing it back to IPs and saying, you’re sending too many… IPs are seeing something there that they believe you should be dealing with because the numbers are going up, but you seem to be quite satisfied with the number that you’re dealing with.”

I was surprised that Dr Judge responded: “To be clear on what I’ve said, there are 5,000 indications of misconduct – I say ‘indications’ because I think that’s an important point; not every one is going to be severe or even, you know, there are people who are innocent in that…” At least Graham Horne tempered this a little with the observation that IPs are statutorily obliged to report metaphorically those driving 31mph in a 30mph zone and consequently not all cases are taken forward, but even so I thought it was interesting to hear what comes into the new Inspector General’s mind.

Pre-packs (10.22am)

The Committee Chairman started: “Widespread dissatisfaction with them [pre-packs]; proposals that had been mooted were shelved earlier this year…” Was there scope for further reform?

Dr Judge repeated the Insolvency Service’s view that pre-packs are seen as a useful tool in the rescue culture, they have saved jobs, and in conducting their monitoring “we haven’t come across widespread evidence of abuse”. He also explained the general view that the real concern is sales to connected parties and that SIP16 has “tried to” address concerns over transparency.

Graham Horne explained the reason the proposals for 3 days notice was shelved, due to a desire to avoid introducing legislation affecting small businesses, “although it has not been ruled out”. He also hinted at the relevance of the director disqualifications, reporting that 161 disqualifications were where directors had entered into transactions to the detriment of creditors; 56 for misappropriating assets; and 102 for “conduct that was quasi-criminal”.

He continued: “Transparency is something that we continue to work on and we’re not satisfied that IPs are doing enough to persuade creditors that they’re doing a good job in the way that they’ve handled pre-packs. We don’t see evidence that the pre-pack wasn’t the right thing to do or that it wasn’t the best option in the circumstances. What I don’t think IPs are doing enough of is explaining to people why they chose that option and giving the circumstances for that”. He confirmed that no other specific suggestions arising from the stakeholder meetings into improving confidence in pre-packs are being considered.

Brian Binley queried the relevance of the disqualification statistics. He added: “It is about SMEs in pre-packs, small businesses who often think that the whole deal is done above their heads; they don’t get any information whatsoever and they feel either that the Inland Revenue or the banks or the big companies have wrapped it up without any recognition of the relative size of the hit to a small business. To a bank, £50,000 is not a great deal of money, but to a small business it’s very often the difference between survival or going under and in terms of pre-packs it is often the SME, the very small business, that is totally left out of any considerations. Is that fair and if there is a hint of concern there, what are you doing about it to find out how great that concern is?”

Personally, I do wonder at the level of acumen of a business that provides life-or-death levels of credit to a company and thus how sensibly they could contribute to, or absorb the details of, any pre pre-pack completion process.

Graham Horne responded that he understood the concern. He believed that the forbearance of HMRC and the banks is helping; companies are not being pushed into insolvency, but he recognised that it is the absence of information before the sale that is the concern. “That is why we’ve not ruled out going back to the idea that people should give notice and we do encourage – and it is part of the practice of IPs – to market the company’s assets because I think one answer here would be to say to people: what is anyone prepared to pay for these assets? Because this is what it’s all about… a fair open market to say what’s anyone prepared to pay? And I think the issue on pre-packs is often that it’s behind closed doors. The SIP is supposed to be telling IPs to give information about what marketing they’ve done and this is where we pull them up and their compliance I’m afraid is disappointing”.

I was interested to note that Graham Horne referred to sales of assets, not businesses, which supports my perception that perhaps he still does not quite appreciate the damage that can be done to some businesses in indiscreetly seeking to attract purchasers before the commencement of insolvency. Having said that, I do wonder if some IPs may still feel that as long as sale consideration is comparable to, or a slight improvement over, a valuation, then it is as good as selling on the open market and I wonder if adequate contemplation of open market selling occurs.

In response to Ann McKechin’s (Labour MP) question of whether the Service was satisfied with the last SIP16 monitoring report’s results – 32% not fully compliant and 7% substantially deficient – Graham Horne stated: “No, I’m not at all satisfied with that. It is disappointing that the industry has been unable to get that level up to where I’d expect it to be. I mean, they are professional people, it’s a complicated SIP and it’s got quite a lot of elements to it, but one would expect them to be able to comply with that to a far higher level that 68%. I would say that the non-compliances are slightly technical, so it’s not as though in those cases that the pre-pack is in any way wrong or was the wrong thing to do or there was abuse. It is simply the point that they’re not giving enough information to creditors and that’s why again as part of the reforms we are looking at strengthening the rules and regulations relating to the supply of information to really put it on a statutory footing, rather than the footing that it is with the SIP”.

I was disappointed that, whilst Ann McKechin was seeking confirmation that “the SIP is at the moment voluntary guidance provided by your department”, Graham Horne nodded and muttered “yes”. Ms McKechin continued by asking whether Mr Horne would prefer it to be statutory. He responded: “I’m not sure that my personal opinion particularly carries much weight, but it is something that ministers would want to look at and it’s part of the consultation that went out”. Then Ann McKechin asked: “Have any of the professional regulators that are involved adopted the SIP16 guidance into their own regulatory environments and the fact that there are penalties for non-compliance?” Disappointingly again, Graham Horne did not put the Committee straight on the status of SIPs within the RPBs, but he responded: “Oh there are penalties for non-compliance, yes, and when we complain, penalties are imposed, fines are imposed and undertakings are given, so there are some regulatory consequences of the failure to comply. My disappointment is that those penalties have not had the impact of improving compliance levels and I think what we’re trying to do with the RPBs is urge them to up the game to say, look, you need to do more, to ensure they do reach acceptable levels of compliance. I think our view is that the penalties imposed so far have not really been of the size, of the level, that we would have liked to have seen in some cases. In some cases we think that perhaps RPBs could have taken a little bit of a firmer line with some of the non-compliance cases.”

Personally, I was really disappointed at the style and wording of SIP16 when it was released (my disappointment perhaps is heightened, as I was the IPA secretariat attendee at the JIC when the SIP was being worked on – I believe that there was plenty of effort on the IPA’s part to get the SIP into a better shape). I do believe that the checklist style has led to some SIP16 disclosures lacking real substance or a sensible explanation of why and how the pre-pack was undertaken. I do think that more could be done to make the disclosures useful, although I fear that the Insolvency Service’s apparent checklist style of monitoring has not helped, as I wonder if some IPs are sticking to the checklist approach in order to prove to the Service that a disclosure does meet SIP16 requirements. If that is the case, perhaps these IPs put too much emphasis on the bullet point list in the SIP when they perhaps should be reflecting on SIP16’s paragraph 8: “It is important, therefore, that they [unsecured creditors] are provided with a detailed explanation and justification of why a pre-packaged sale was undertaken, so that they can be satisfied that the administrator has acted with due regard for their interests”.

I would hope that the JIC could be left alone to revise SIP16 (and perhaps SIP13 too?) – and when I left the IPA in May this year, a JIC working group (including someone from the Insolvency Service) was working on this endeavour. However, it is clear that the threat of the current SIP16-style legislation remains alive.

Complaints in general (10.39am)

Ann McKechin followed up an observation that complaints against IPs had fallen by 16% with an interesting question: does this reflect the value of cases at present or is it an indication of increased confidence in the profession? Unfortunately, the Insolvency Service did not grasp hold of this idea, but instead Graham Horne responded: “If you read the OFT report, you might think it was possibly because of a lack of awareness of how to complain and maybe there’s a little bit of an issue there about the mechanisms by which you complain, the way in which you complain. Levels of insolvency are fairly static at the moment, so we would not expect increasing levels of complaints and IPs in fairness do a difficult job and do it well in the main and the level of complaints is comparatively small compared to the sorts of cases they deal with.”

Evolving plans for changes to complaints processes

Graham Horne immediately continued: “What we are doing is trying to work with the RPBs on a measure to have a single gateway for complaints and we’re pretty close to hopefully announcing a basket of measures where we will host a gateway for complaints so people will be able to see the way in which they can complain.”

He confirmed to Ms McKechin that this was considered an alternative to the creation of a single complaints body and he added: “we’re close to hopefully getting ministerial approval to launch shortly. We’re also working on common sanctions so it won’t matter which body you’re complaining to, there’ll be a consistent approach to the misconduct, common appeals process as well, so you get many of the advantages of a single regulator but by bringing it together with a single front-end and approach to complaints.”

Prospects for a single regulator (10.41am)

In response to Brian Binley’s question regarding the apparent demise of the proposal for a single regulator, Graham Horne acknowledged that the consultation had generated “quite a lot of strong support for that”, but that “ministers have ruled out at this stage legislation. The previous minister said he would want to explore achieving the same aims through voluntary means, which is this package of measures I’ve been talking about… We haven’t ruled out and ministers haven’t ruled out a single independent regulator, needs Parliamentary time, needs to think about that, but what we’re trying to achieve through this set of measures is some of the advantages it would give us.”

Mr Binley observed that R3’s survey reported that the vast majority would like fewer regulatory bodies and asked how quickly the Service was moving, to which Mr Horne observed that it is in the hands of ministers. Dr Judge added that they “could probably reinforce” the Service’s oversight function; he noted that they are limited to the “nuclear action”, but he pointed out that it did not stop the Service from making their expectations clear to the RPBs.

Creditors’ powers to challenge excessive fees (10.48am)

Rebecca Harris (Conservative MP) asked what progress was being made in enabling creditors to challenge excessive fees. Graham Horne responded: “This is an area where we’ve made some progress, but I have to say not as much progress as we would have liked with our dealings with the RPBs… They will be able to raise complaints about fees and RPBs will look at those where the circumstances surrounding the fees amount to misconduct – so an IP has not got proper authority for fees, where an IP cannot support a calculation for the fees, or where the fee levels are very egregious – so they will look at those and that will give creditors some avenues to complain. The position is still that in most cases the recourse is to the court if you’re not happy with the way IPs have handled fees. Most fees are approved by creditors… We are looking at whether we can push this voluntary measure a little further because the recourse again would come back to legislation and we haven’t ruled out looking at secondary legislation to give RPBs the right to examine the quantum of fees and I think their natural concern is getting into a commercial discussion/debate about: was that the appropriate fee in that particular case? We think it is right that there should be some mechanism where someone looks at that and decides whether, not down to the last pence (he was interrupted by a Committee member asking another question)… We are doing all we can in our role as creditor, albeit we become a creditor after the event, to use our powers as a creditor to look at IPs’ conduct and to raise issue and HMRC do quite a lot as well, although they would have to take it on a resource basis; they can’t take on every case because they are a creditor in every case.” Mr Horne’s additional comments suggest that the Insolvency Service has devoted new resources to this endeavour and recently formed an RPO team to look particularly, from a creditor’s perspective, at how IPs have administered cases.

The Red Tape Challenge (“RTC”) (10.53am)

Graham Horne set out the timescale: the revised rules are planned to come into force in October 2014 and a set of rules will be sent to a focus group in early 2013. He said that the revised rules would be made available to the public at least 6 months before implementation, as he appreciated that people needed time to adjust their systems. Personally, I thought that suggestion of any public consultation on revised rules was conspicuous by its absence.

Mr Horne explained that the “D-form issue” was a particular issue arising from the RTC; the rest of the suggestions were generally around the process of insolvency, meetings, whether modern means of communication could be incorporated more widely, for example with the current need to use first class post. He said there were no big ideas, but “incremental pruning” should make reasonably significant improvements overall.

Mike Crockart referred to the apparent desire amongst IPs for an electronic D-form, but commented that it seemed a “moratorium” had stalled this development. Graham Horne confirmed that the idea was certainly not shelved but he acknowledged there were some legislative barriers to look at. He also said that the Service wants to take a wider look at the whole D-report/return process, for example is a D2 nil return really necessary? Should there be a form or reporting requirement? He noted that the risk of a form is that it becomes something completed by rote.

The above words were what the Chairman used to introduce the next subject and he then handed over to Brian Binley: “I understand you are to meet with officials from the BIS department and with the Treasury and the Campaign for Regulation of Asset-based Finance – due to take place this week”, although Graham Horne later said that discussions were ongoing, rather than confirming a meeting this week. Mr Binley referred to a case involving a bakery which was given 2.5 days over the Jubilee period by Bibby to find other funders and then Bibby wanted a £92,000 termination fee. He asked whether this kind of power was unfair and continued: “Some factoring companies put companies into administration and appoint a friendly insolvency firm and some go even further – they pass leads to lenders who are owned by the insolvency practice firm themselves. Now this is pretty-much of an unacceptable mess, isn’t it?”

Dr Judge acknowledged that this was a relatively recent concern brought to the Service’s attention and pointed out that the Service’s function is limited to insolvency and that this appeared to fall to other departments. He encouraged people to provide specific evidence of any concerning events. Graham Horne’s follow-up comments suggest to me that the Service may not have fully grasped Mr Binley’s particular concern: “I think that the regulatory framework is in place. We don’t need any more tools. If people have taken out charges late-on prior to the insolvency, those charges could be rendered invalid. These sorts of things can be looked at in the way the company’s business was restructured just before the insolvency. This is stuff that we can do with our current powers, so what we need to do is get complaints to us. We’ve got powerful powers to investigate companies.”

Mr Binley was keen to highlight the banks’ role in this matter, although in so doing, I wonder if he is muddling two different issues: “It’s the banks that almost stipulate that some of their small businesses actually use an associated factoring company, so the whole loop sort-of has the smell about, which is not overly savoury.”

Shortly afterward, the Chairman wrapped up the session by reminding the Service representatives that further written evidence covering a number of matters was expected – the story continues…

I think there needs to be far less talking and much more action. This whole Pre-Pack situation is being hugely abused by greater or lesser degrees. New legislation – like the rules to give victims of burglary more protection for taking positive action , is required for creditors, who are the victims here; They need protection from unscrupulous directors and in some cases IP’s.

Thank you, James, for your comment. If you have any knowledge of IP misconduct, I would encourage you to lodge a complaint with the IP’s authorising body.

Personally, I believe there is already adequate legislation to tackle unscrupulous directors and IPs. In addition to the ability to deal with directors under the Company Director Disqualification Act 1986, legislation provides for the claw-back of pre-insolvency voidable transactions, e.g. transactions at an undervalue, and this often recovers significant sums for creditors.

As for unscrupulous IPs, the legislation is also there to deal with misfeasance and they work in a highly regulated environment, which involves regular on-site monitoring and complaints investigation. The Insolvency Service has worked hard over the last few years to encourage people to complain – and past Insolvency Service SIP16 monitoring reports describe the work the Service has done in investigating complaints it has received. It seems from the BIS Committee session that Graham Horne is comfortable that IPs are not undertaking questionable pre-packs, but his concern clearly is that some IPs are not explaining their actions adequately. It is not surprising to me that inadequate explanation often results in distrust and suspicion as to the IP’s motives and strategies, but effective communication with creditors seems to me to be something that IPs need to do for themselves (with appropriate persuasion from the regulatory bodies); it certainly does not appear to me to be something that legislation is good at tackling.